Posted on 07/06/2004 4:09:13 PM PDT by Remember_Salamis
The FairTax and Investing
We must replace the income tax with a national retail sales tax (NRST), also known as the FairTax. This can be accomplished by passing the Fair Tax Act of 2003, known in the House as HR 25 and in the Senate as S 1493. The FairTax would replace all income and payroll taxes for both individuals and businesses with a tax-inclusive 23% NRST. Only goods and services purchased at the retail level would be taxed, while all goods and services purchased by businesses would not be. Because taxes will only be collected at the sales counter, there will no longer be any capital gains taxes on savings and investment. In order to ensure that we don’t end up with an income tax and a NRST, we must also repeal the 16th Amendment.
Since capital gains taxes will be abolished, the cost of borrowing money will also drop. A 25-35% drop in interest rates is expected after the FairTax is implemented. The reason for the drop is because lenders will no longer tack on a 25-35% surcharge to cover the taxes they will have to pay. This can be seen today in tax-free bonds, which are typically 30% less than their taxable counterparts.
With interest rates at their current 6% rate, a 30-year, $300,000 mortgage would cost $1,800/month. While that’s excellent historically, under the FairTax system that same mortgage would only cost $1,200/month (a 4% rate). In essence, the FairTax would increase home buying power by 50%! However, not just homebuyers would benefit. The FairTax will lower interest rates and increase the capital available for business investments. As a rule of thumb, the lower the interest rate, the larger the pool of capital. The “true” value of a corporate stock or bond is fairly simple to calculate: it is the expected future income from owning the asset plus the interest rate.
If a firm's expected future income stream increases, then the stock will increase in value. If a firm's expected future income stream goes down, then the stock price will fall. If the expected future income stream from a bond declines due to a heightened risk of default, then the price of the bond will fall.
When interest rates rise, the present value of the corporation's future income declines and stock prices decline. Since interest rates will be lower, stock and bond returns should rise accordingly. In addition, the FairTax will dramatically increase investment levels because savings will no longer be discouraged.
The US has lower rates of capital formation and savings than most of its major trading partners, including Japan, Germany, France, the Netherlands, Italy and Canada. This is due to the current tax system, which discourages savings and investment by taxing capital gains. Under the FairTax, the more somebody saves, the lower their effective tax rate is. Therefore, savings and investment will increase. Furthermore, capital gains tax would be repealed, encouraging even further investment.
Under the FairTax, corporate bonds and municipal bonds would be treated equally by the tax code. Currently, corporate bond rates have a higher interest rate because they are taxed and the risk of default is higher. Municipal bonds (or MUNIs), on the other hand, have lower rates because they are not taxed and the risk of default is lower. As a result, high-income individuals invest in tax-free municipal bonds while low and middle income individuals invest on corporate bonds. The bond-neutral FairTax will let bond investors invest in corporate bonds or municipal bonds, depending on the individual investor’s risk tolerance. Bondholders will shift more assets towards corporate bonds, which will benefit the private sector at the expense of the public sector. As a result, government will find much harder to raise funds because there’s less money being thrown at after tax-free MUNIs. However, the private sector will find it much easer to raise needed capital. Last year, the President passed a cut in dividend taxes. The purpose of this was two-fold: (1) to increase the appeal of investment, and (2) control corporate malfeasance by promoting dividend options. While the move was much-needed, corporate malfeasance on the Scale of Enron, Tyco, or MCI WorldCom will be nearly impossible under the FairTax. Under current law, the recipient of dividends is taxed three times. First, a shareholder must purchase the stock after taxes. Next, the company must pay corporate taxes. Third, the dividend holder must pay taxes yet again on dividends. As a result of triple taxation, many companies prefer not to offer dividends because it’s simply another layer of taxation. Instead, companies keep the money internally and pass on profit growth in the form of increased share prices. However, this can lead to stock manipulation, such as Enron, where the company “fudged” the numbers in order to make the share price rise. Under the FairTax, this would not be possible because profit growth would be directly passed on to shareholders, not stuffed away in some dark corner of the company. Simply put, dividends are the best evidence of a healthy business. You can't fake a dividend; it's hard cash.
Here's the first topic-specific FairTax thread that we talked about.
I simply can't see it passing, given current political realities.
I can, however, see us moving towards a consumption-based tax, one small step at a time, through increased options for tax-free savings and investing.
First the IRA, then the 401k, then health care cafeteria plans, then the Roth IRA, the Health Savings Accounts, etc.
We're getting there, one step at a time.
As a mortgage broker, I support this. I always have, but this is even better. Although we'd lose the mortgage interest deduction, the improvement in rates would more than make up for it. Even back in '00, though, while working in a totally different industry, I was a NRST supporter. After all, unlike the DimoRats, I have a concern about America, not just myself, despite the fact that almost everyone would benefit economically from this.
Don't forget the reduction in the number of tax brackets. Also, the reduction of the capital gains tax and dividend tax. Most importantly, the elimination of the death tax.
I agree, jdege, there has been significant incremental movement toward a consumption tax already. Consider it one of Ronald Reagan's legacies!
I see, in some of what he is doing, the sort of under-cover transformative policies that Reagan used.
The reason we've not been able to roll back the New Deal is that it was designed to create a constituency for itself.
Reagan understood the necessity of creating pro-market constituencies, in fighting the socialist ideas that he saw as so destructive.
We'd be a very different place, if Reagan hadn't approved 401k plans, or allowed the states to experiment with welfare reform.
It's because of those changes that we're able to discuss issues like social security privatization with some real chance of accomplishing it.
Bush seems to be consciously making the same sort of policy decisions.
And in doing so, he's driving nails into the coffin of the "Democratic Wing of the Democratic Party".
You're right. It's a hard-sell in any political environment.
It needs an incremental approach. Establish enterprise zones where businesses and residents pay the NRST versus income tax by choice.
When the bugs are worked out, take it nationwide.
Would love to see it in my lifetime and preferably soon as I think it would give us all a less stressful better quality of life.
Actually, it doesn't get rid of the deduction. In fact, it EXPANDS it for those buying used homes.
Under the current system, only interst goes "untaxed" (still pay payroll taxes). Under the FairTax, an entire mortgage payment would go untaxed if it was on (1) a preexisting mortgage or (2) a purchase of a used home.
And it's those that buy used "starter homes" that are the ones on the fence between owning and renting. With the option of either a 100% deduction (owning) or a 0% deduction (renting), the homeoweners' market will swell, driving property values up along with it.
One only has to look at the change in mortage rates which were at around 5-6% in the 50s and 60s when the maximum income tax rate was 91%.
US long term interest rates were in the 8 to 9 percent range in the 1790s with no income tax, and dropped into the 2 to 3 percent range during WW II where they remained until the 60s when the maximum tax rate dropped to 70 to 75 percent. The long term interest rates then increased year after year until the high of 14 percent in 1981. Yet the maximum tax rates remained at 70%, though there was a slight increase in the capital gains tax during that period.
The Reagan tax reduction of maximum rates from 70% down to 28% produced no measurable decrease in long term interest rates. The Clinton increase to 39.6% resulted in a continuing decline in long term rates, not an increase.
Interest rates historically have been the result of many economic factors, but neither mortgage rates nor other interest rates appeared to have been materially impacted by the changes in the income tax since 1913.
Low municipal bond rates which are havens for high rate tax payers will likely increase, however, because they are directly impacted by being tax havens, in that, there is no substantive reason to invest in a muni except for the tax benefits. With no income tax, either local municipalities will have to increase taxes immediately, or continue to rely on the safety aspect of the bonds.
I do agree that the income tax itself, imposed on corporations, has a detrimental impact on the firm's ability to expand. With no tax payments however, while there will be a corresponding increase in net income, there is still no guarantee of increased dividends, as the company may use the funds for growth, not to pay the owners. If, however, as the author believes, dividends will increase, then I can invision little positive expectation for an increase in the growth of the company resulting from the end of the income tax.
As I said at the beginning, however, there are many excellent reasons for exchanging the income tax for a consumption based tax of some kind. I don't support the current efforts, however, because they encompass other kinds of taxes, which make passage of them virtually impossible.
I've been toying with that idea myself lately too. But what if we introduce a small NRST, say a 5% NRST to replace the labor, I mean payroll, tax. A few years after that we can eliminate corporate taxes and up the NRST to 6.5%. We'll then eliminate death taxes and up the NRST to 7%. Next we'll remove Capital Gains taxes and up the NRST to 10%. At that point we'll only have two major forms of taxation: the NRST and the income tax. At that point we can pass legislation mandating that the income tax be incrementally converted to the NRST, with 10% of the income tax converting to the NRST every year for 10 years. At that point, we can finally kill the income tax by passing a constitutional amendment forever banning it.
As an added bonus, these incremental steps will give the GOP something to campaign on for a decade or so.
Of course, there is risk in this approach: turning the labor (payroll) tax into an NRST may accidentally save Social Security, avoiding it's needed collapse and total privatization.
Thoughts???
If you would like to be added to this ping list let me know.
John Linder in the House & Saxby Chambliss Senate, offer a comprehensive bill to kill all income and payroll taxes outright, and provide a IRS free replacement in the form of a pure consumption tax:
H.R.25, S.1493
A bill to promote freedom, fairness, and economic opportunity by repealing the income tax and other taxes, abolishing the Internal Revenue Service, and enacting a national retail sales tax to be administered primarily by the States.Refer for additional information: http://www.fairtax.org & http://www.salestax.org
I'm very much opposed to replacing the payroll taxes with a national sales tax.
The payroll taxes pay for items that should be entirely privatized.
How about this: we privatize medicare and social-security, requiring that all income earners pay whatever the percentages are into privately-held accounts.
Although we'd lose the mortgage interest deduction
Think about it, you don't lose the deduction, a deduction just means you don't pay tax on something. Under the NRST, one does not pay tax on interest paid or received.
You would pay tax on any brokerage fees, and insurance premiums (the term in the legislation is financial intermediation services.) which come under the rubic of services that might be included in a mortgage payments but none on the interest or principal of the loan.
Thanks for some rationale discussion. There are some advantages to a sales tax, but the NRST folks greatly exagerates any advantage. Besides, I can see a ton of loopholes and huge black market created. In the end, any system that sucks out $2 trillion out of our economy will load down our economy in a similar fashion and will have to be intrusive in order to collect that amount of money. The biggest advantage I see is adding a sales tax on foreign made goods will make our products more competitive.
At that point we'll only have two major forms of taxation: the NRST and the income tax.
Therein I see a great deal of danger, there is nothing whatever to prevent the expansion of both putting us into even worse condition than we are today.
One of the reason to push for a whosale change of the system instead of incremental, is to assure that we don't end up with a more complex, and more politically manipulative system than what we already have.
There are several substantive goals of enacting an NRST,
1) visibility of rates and universal participation of all voters perceiving a proportionate level of taxation. Every voter should be congnizant of the cost of larger government and more largess.
2) reduction of complexity to reduce the overhead burdens of complying with the nation's tax system. On average, our large businesses see as much as 65cents added on to their operating costs for every dollar of federal taxes extracted through them. Smaller business are impacted even greater where there costs can rise to as much as 2-5 times and more the tax the fork over to the feds.
3) removal of the large and intrusive bureucracy hanging over every household in the nation out of the necessity of validating an enforcing the income and payroll tax laws on the individual level.
4) reduction of the opportunities for Congress to impose taxes for social and political engineering purposes. When everyone perceives the change due to actions which move to raise rates overall or impose additional taxes on already too high rates, the electorate has a great deal of leverage. Look at what happens whenever state or local government tries to raise sales tax rates. Everybody and is uncle get into the fray and that is the way it is supposed to work out. Make raising and adding taxes a high political risk.
The NRST is more than just changing tax law because we don't like the current system. It is much more fundamental than that. The NRST is an attempt to create the conditions for change in the electorate and our responses to government in very fundamental ways. It is a change in the entire paradigm to return us to the early time where it could truly be said:
McCulloch v. Maryland, 17 U.S. 316 (1819)
- "The power of taxing the people and their property is essential to the very existence of government, and may be legitimately exercised on the objects to which it is applicable, to the utmost extent to which the Government may choose to carry it. The only security against the abuse of this power is found in the structure of the Government itself. In imposing a tax, the legislature acts upon its constituents. This is, in general, a sufficient security against erroneous and oppressive taxation.
How about we replace it w/ the NRST and slowly reduce the NRST/SS tax until people keep their own money and decide their own furute?
Wrong!
>
They sure go a long way to explain who, how often and what the basic interest rate is to not be taxing "interest bearing investments, accounts, and debts".
I totally agree with you, but maybe we should have a backup plan.
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